Snowfall weather derivatives out of favour, says report

The market in exchange traded snowfall derivatives has all but ground to a halt, according to a report from CNN, resulting in not even a single snowfall-linked weather derivative contract being traded on the Chicago Mercantile Exchange (CME) in 2013.

Snowfall derivatives have been available to trade on the CME for a number of years. They offer a mechanism to hedge against extreme levels of snowfall or a lack of snowfall, depending on which side of the hedge matches your business need. As with other forms of weather derivative contract, such as temperature or rainfall, they pay out based on actual weather measurements taken from approved weather stations or measuring points.

As recently as 2011 the CME traded 510 snowfall derivatives in a year, according to the CNN article, but in 2013 that fell to zero. After a brisk start the market in snowfall derivatives seems to have  moved off exchange and become more focused on customised weather contracts, which may use weather derivatives as the ultimate hedge but often look much more like insurance or reinsurance to the end-user.

The article suggests a number of reasons for the lack of uptake of snowfall derivatives, including the fact that many consider these types of derivatives complicated or esoteric, that we haven’t had enough heavy snowfalls in recent years and more users want protection from extreme snowfalls rather than a lack of snow.

A very good point is made by Brian O’Hearne, CEO of eWeatherRisk, who says that his firm is looking to create a snowfall contract which would protect across the number of storms, rather than the depth of a single significant snowfall. This aggregate protection may be much more suitable for certain end-users, providing protection across the winter season.

An example might be a retailer, who suffers a loss of footfall every snowfall of the year. Protecting against a 20 inch dump of snow likely isn’t the result this type of user of snowfall derivatives wants, but protecting against lost earnings due to snowfall across a winter season would be more attractive.

Weather derivative markets have always shown huge promise but rarely lived up to this. Through customisation and innovation, as well as closely matching the protection to the real coverage needs of users, weather derivatives such as snowfall contracts may be able to find more traction. Whether they need to stay on exchanges is another question, but the development of tradable indices, rather than snowfall depth reporting, may be of some help here.

We’ll have to wait and see whether the cold and snowfall experienced in the U.S. this winter will be sufficient to trigger more interest in snowfall derivatives for the winter of 2014.